Posted by John Yerou
on March 20th, 2013 16:21pm in
Last Updated on December 23rd, 2018 18:35pm.
Why do professionals forego the security of full-time employment to become independent contractors? The most compulsive reason is the opportunity to earn more as a contractor. But is the headache of running your own company worth the extra income? That’s what we’re here to find out.
Table of Contents
- Managing Cashflow and Contract Continuation
- Building a Savings Safety Net and Insuring Your Lifestyle
- Accountants: Don’t Tackle Tax On Your Own
- IR35: Don’t Start Contracting Without Understanding This Risk
- Hide and Seek High Street Mortgages
- Find Your Way to Financial Freedom
- Networking and Upskilling: Make the Most of Opportunity
- Flexibility: Don’t Believe (all) the Hype
- How to Get the Mortgage Your Income Deserves
- Contractor-Friendly Mortgage Lenders: Worth the Risk
The Argument Against: Barriers That Stand in the Way of Success
You shouldn’t consider contracting if you think it’s an easy way to get more for what you do already. Contracting will reward you if you’re prepared to work hard at it, harder than you do now as an employee.
It’s a completely new way of life; you need to grasp the detriments as well as the benefits. We’ll start with the toughest challenges new contractors face. If you can accommodate these changes, part two of this guide will be a breeze!
Managing Cashflow and Contract Continuation:
A huge part of contracting is that you are self-employed. That sounds obvious. But don’t be blazé about the switch from permanent employee to contractor.
As an employee, the longevity of your employment contract is in your own hands. Professional contracts differ in that they have a firm begin and end date. At most, your contract will be 12 months. It’s crucial to secure extensions or have a new contract awaiting following your current one.
Ultimately, it’s down to you to keep the cash coming, the contracts concurrent. Be on the lookout for your next opportunity well in advance of the end of your current contract.
Also, keep your ear to the ground where you’re working on the current contract. Part-time or non-contracted staff are the first to go if a firm’s looking to reduce headcount.
You’ll still have the inherent financial commitments you had as an employee. You must ensure that the rate you charge (or an agency offers) covers existing outlay and savings.
Building a Savings Safety Net and Insuring Your Lifestyle:
For contractors more than anyone, building a safety net is critical. You may have dry spells, as we alluded above.
You’ll also want to take holidays. Your higher income will bring the likelihood of having more income disposable towards them. Yet you may have to work the longer bucket list breaks around contracts.
You may need time out for all manner of reasons. The volume of work and the rate you charge for undertaking it must cover all these bases.
Of the times you don’t plan for being absent, sickness is a major concern. You no longer have access to employer’s sick pay. If the worst happened, you won’t have death in service benefit either.
Yet you will still have to pay the bills or provide for your loved ones if you die. Mortgage repayments, living expenses and utilities won’t disappear. The latter, you’ll rely on more if you’re stuck at home, sick, not to mention home entertainment.
In recent years, more bespoke insurance policies have come to market for professional contractors. They now allow you to maintain your contractor lifestyle when you’re ill, mid-long term.
An IFA will help you understand the right amount of cover you need. Once identified, you should take those policies out at your first opportunity.
Accountants: Don’t Tackle Tax on Your Own:
As the owner/director of your own limited company, you are responsible for its finances. As well as what you decide to pay yourself, you’ll be responsible for all taxes
As a past employee, you’ll have paid only employee’s NICs and income tax (PAYE). As a contractor, you will have employer’s NICs, VAT and corporation tax to consider, too.
That doesn’t mean you have to work them out or prepare them yourself. That’s a task in itself, as the taxation law rules changes at almost every budget. You’d have to spend inordinate time each year working out the perfect strategy from year to year.
A good contractor accountant will do that for you and help you claim all reliefs. But you should be aware of deductions, net profit and how they affect your status.
You’ll then be responsible for submitting your Confirmation Statement to HMRC. (That’s your “Annual Return” in old money.) That document confirms that you’re submitting a true account of your business finances. As a limited company, these figures will be available on Company’s House.
The umbrella route may cut down the amount of accounting you need to involve yourself in. They will issue with a payslip each week for the work you’ve undertaken. For an extra fee, they will also prepare your accounts for submission for you.
IR35: Don’t Start Contracting Without Understanding the Risk
This overview of the downsides of professional contracting wouldn’t be complete without mentioning IR35. Intermediaries Legislation is the biggest Dementor on the contracting landscape.
IR35 exists to stop companies and employees exploiting tax relief availed of limited entities. Why would they do that?
Well, it’s cheaper for an employer to hire a contractor. Said contractor would “take home” more with the right tax planning strategy.
Seeing the benefits, employees were quitting on a Friday with their employer’s consensus. They were then coming in the next Monday to do the same job, but as a contractor. The tax man was having none of that!
So HMRC created the IR35 team to uncover these disguised employees. The problem? There is no definitive way of proving or disproving a contractor’s status on paper. Anyone the IR35 team suspects of being “inside” IR35 they’ll subject to an investigation.
Each investigation could take months, even years. And whilst under investigation, the contractor will go onto the PAYE system. This means they’ll lose almost all the perks of being a limited company entity. But, they will still have to pay the associated additional taxes.
The net result? They’re worse off “inside” IR35 than either being “outside” or even than an employee. The best advice is to act like the company you purport to be at all times.
Hide and Seek High Street Mortgages:
Contractor mortgages is an odd topic. The first nugget of truth: most lenders can’t process limited company accounts in-branch.
The industry still considers mortgages for contractors a specialist area of lending. That’s despite true contractor-friendly products being ‘prime rate’ loans. And despite more lenders offering a version of the Halifax’s groundbreaking template.
But most lenders who do offer them have specialist underwriters or go through intermediaries. Either way, you won’t get a competitive mortgage in-branch, if an offer at all.
The best you can hope for is a self-employed mortgage. These don’t optimise your limited company income strategy, using only your net salary.
The bulk of your income you hold within your business as retained profit. As such, it’s off limits to generic advisors in-branch. The key is to use a specialist broker. They will understand contracting and have access to specialist underwriters.
As promised, we’ll tell you more about how this will benefit you in the in the “Pros” section. Talking of which…
The Argument For: Why Contracting is a Growing Industry
Are you still with us after that eye opener? Ready to find out why contractors put with so much? This! This is why so many professionals are now independent limited entities, not employees:
Find Your Way to Financial Freedom
How can you do the same job as a permanent employee, yet be far more financially secure in it? As a limited company contractor, you have a double advantage.
First, as alluded, put a savvy tax planning strategy in motion as per your accountant or IFA. The reliefs to which you’re entitled will see you hold onto more of your top line day rate.
Talking of which, and second: that day rate. Most contracts remunerate by the day, rather than annual salary or hourly rate. Contractor finances, like mortgages, use that day rate to work out repayment affordability.
As a contractor, potential clients see you as a specialist in your niche. Plus, they know they don’t have to worry about sick pay, holiday pay and working out your taxes. As such, your skill or service commands a much higher rate than that of an employed counterpart.
Another change is that you’re paid by the week, not monthly. You will submit your timesheet for the week to your client. Following line manager sign off, they’ll pay the gross amount into your limited company. Therein, you’ll draw optimal salary and dividends, as advised by your accountant/IFA.
By contrast, an umbrella contractor won’t receive the gross value of their contract. Their umbrella company will deduct taxes and NICs and pay in the net amount.
Networking and Upskilling: Make the Most of Opportunity
The nature of the assignments you take on as a contractor enable you to grow. Not only across a broad spectrum of industries, but also as a valuable commodity.
The more companies you work at, the greater your all-round knowledge. You’ll meet other contractors who’ll invariably help you to learn the ropes. They’ll pass on their knowledge, tips and experience providing you’re amenable to their insight.
At the outset, your learning curve will be steep. Having someone to bounce off will help you get to grips with the contractor lifestyle. They’ll also help you get the best results from the work you do.
Before you know it, you’ll have a portfolio of sought-after skills. And when you get assignments you love, you’ll come to learn where your expertise lies. Open your mind to learning new skills; take on relevant, complementary tasks. You may find that your talent lies in an area you never dreamed it lurked. If not, everyone loves a trier, right?
With this attitude, one day you’ll experience a Eureka! moment, more than likely on the way home. You’ll realise that you were the one today passing on your acumen to the newbie contractor.
All that said, contracting is no different from any other way of working. The more you put into your work and how you conduct yourself, the greater the rewards. As soon as you start giving of yourself freely, you become the expert. Often without realising it.
That’s when word will spread around your network of contacts, clients and agencies. Your hard, honest work will come home to roost.
Those clients and agencies will start approaching you! You can — often — charge a little more, as you’re the one in demand. And that is the beauty of contracting.
Flexibility: Don’t Believe (all) the Hype
As a contractor, you’re your own boss. But don’t let that fool you into thinking that you can boss clients.
In many guides like this one, firms (who should know better) harp on about how flexible life is as a contractor. In a sense, yes. You can choose your next contract, once you’ve built a reputation. Or if demand outweighs supply for your particular skill, of course.
But those guides give the wrong impression, IMHO. You still have to be professional; that’s inherent in independent contracting. Your clients will still expect you to do a proper job for the duration of that contract.
In most instances, you will be working on your client’s site alongside permanent employees. You can go in there with the attitude that you’re the contractor free to do what you want. But it just doesn’t work like that.
You’ll gel better with other employees (and line managers) if you adopt overarching policies. That comes with the caveat that you don’t take perks, off-site company training or a parking space. You should avoid anything that could make you look like an employee to an IR35 team.
With regards to hours, you may not even have a choice. 7½ hours, 5 days a week, end of story. If that’s how it’s got to be, you’ll get the best results by toeing that line.
After all, it’ll be that line manager who signs off holiday. It will be they who sign off your weekly timesheets. It will be they who report back to the agency (if applicable) and can help build your reputation.
Also, you could take as many weeks off between contracts as you’d like. But the same goes for agencies. They want contractors who adopt a similar ethos to hard work and fulfilling contracts as they do.
When it comes to things like mortgages, those weeks between contracts count. Here’s why.
How to Get the Mortgage Your Income Deserves
As we alluded in the “Cons” section, mortgage lenders struggle with contract income in-branch. One reason for that — and by no means the only one — is security.
The length of average contracts is 3-6 months. When untrained High Street advisors put that into their formula, it raises alarm bells. It:
- isn’t permanent;
- isn’t accounts-based, annual self-employed accounts SA302;
- is a short-term contract with no guarantee of further employment once it’s run its length.
To avoid this scenario, use a specialist broker for your mortgage. Most mainstream banks now offer a form of contractor mortgage. But you’ll find most offer them through a subsidiary of the main household name brand.
Even then, many only accept contractor mortgage applications through trained brokers. Such brokers deal with the lender’s underwriters direct, not in-branch. And they know which contractor-friendly lender is best for your unique circumstances.
Contractor-Friendly Mortgage Lenders: Worth the Risk
Contractor-friendly mortgage lenders — as the name suggests — get the nature of contracting. They know why contracts of this nature exist and the type of professional who undertakes them. So, if you have a history of concurrent contracts, the likelihood is they’ll see you as low risk.
Great! But that’s rather the point: the ‘concurrent’ bit.
Just because a contractor earns more, it doesn’t mean their underwriter can ignore risk. They need to prove loan security as much as the next lender, if not more so.
What they do is work out an annualised affordability figure based on your day rate. They base that annualisation on either 46 or 48 weeks of the year, depending upon their criteria.
Now, if you’re taking three months off between contracts, it nullifies that calculation. In that scenario, you’d be working 39 weeks, not the 46 or 48 they expect. Ex-pect!
Okay, the odd one or two lenders accept 12 weeks between contracts. But they’re the exception, not the rule.
So, just rewinding to “Flexibility”: yes, you can take weeks, months off between contracts. But you need a lender to see you in a positive light to get the mortgage you deserve. As longer breaks will affect your annual income, they might not be so good an idea, after all.
Beyond that, getting a mortgage as a contractor is plain sailing, providing you:
- work the 46 or 48 weeks upon which lenders calculate day rate annualisation;
- use a contractor specialist mortgage broker;
- have a history within the industry you’re contracting and can back it up with a CV;
- and, more often than not, have a good credit history.
If you can tick all those boxes, you will get a competitive mortgage based on your day rate. No need for accounts, that won’t do much for your chances after tax planning, anyway. And because lenders use a multiplier on your gross day rate, what you can afford will surprise you. In a good way!
So that’s it. The good and bad of contracting. Your attitude and drive to achieve your dreams are what will make contracting a success. Or not. Yes, the potential’s there. But is it in you? Only you can answer that. Good luck!
Further reading: guides for standalone, in-depth concepts referenced above:
- Contractor Insurance | QDOS contractor
- Limited Company or Umbrella?
- IR35 Legislation | Contractor Weekly
- The optimal salary and dividend drawing for contractors 2017/18
- Contractor Mortgage Lending Criteria
Author: John Yerou
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.